There are many financial products you can choose to invest in as a part of your retirement portfolio. One of the most complex is an annuity, which is a product that requires a premium payment up front in exchange for a guaranteed retirement income later in life. Generally speaking, annuities are safe and can be a good addition to your retirement plan, but you do have to be careful and make sure you’re buying the right products from financial institutions you trust. Let’s break down the risks and benefits.
For help adding annuities to your portfolio, a financial advisor can walk you through different options for your retirement needs and goals.
Annuities Defined
An annuity is a contract you sign with an insurance company where you pay a predefined premium up front in exchange for payments down the line, likely when you are in retirement. Annuities are popular with retirement investors because they provide guaranteed income during retirement, essentially replacing the pension payments that many workers got in earlier eras.
There are many types of annuities, but generally they fit into two broad categories:
- Fixed annuities are the most popular type. This annuity guarantees that you get back all of the principal you put in, plus a small amount of interest. These are not very risky, but you don’t have the chance to see your money grow the way you might with a different investment.
- Variable annuities have no guaranteed interest. Your principal is generally guaranteed, but the interest depends on the performance of the investments your money is put in. Variable annuities have higher potential for return but also come with significant risk.
Are Annuities Safe?
As long as you are buying from a reputable insurance agency, you can feel safe in purchasing an annuity. That said, it is important to note that annuities are not bank deposits and therefore are not insured by the FDIC. This means that in the result of a systemic collapse, annuities would not be covered by that safety-net. There are state guaranty funds for insurance company collapses in some states, but it varies.
Variable annuities are less safe than fixed annuities, as the payout from a variable annuity is much more dependent on the market. That said, you are still guaranteed to get your principal back, so you won’t technically lose any money. Though, your money will be worth less when you get it back in your retirement, due to inflation, so you are at risk of losing value.
How to Pick the Right Annuity
When purchasing an annuity, the key to feeling safe in your investment is to pick a quality insurance company. Check the firm’s credit ratings — there are four credit ratings agencies in the United States to look at: AM Best, Fitch, Moody’s and Standard & Poor’s. If a firm has a high rating from all of these, you can probably trust it. If it doesn’t, you might consider looking elsewhere.
Beyond that, consider how much you are able to pay in premiums and what type of payments you want to get in retirement. For a truly safe investment, look for a fixed annuity. If you’re willing to take a bit more risk, consider a variable option. Either way, getting the help of a financial advisor is a good idea.
One note when it comes to getting a financial advisor’s advice on annuities — some advisors, commonly called fee-based advisors, can earn commissions for selling insurance products, including annuities. This gives them a financial incentive to sell you the annuity that will bag them the biggest commission, even if it isn’t the best choice for you. For unbiased advice, find a fee-only advisor who does not earn commissions.
Bottom Line
Annuities are safe investments, provided you work with a reputable insurance company. As long as you’re confident in the financial soundness of the insurance company selling you the investment, you are guaranteed to get at least your principal back, depending on the type of annuity you purchase.
Financial Planning Tips
- For more help with annuities, consider working with a professional financial advisor. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Outside of annuities, you should make sure to use a workplace retirement plan like a 401(k) if you have access. Make sure you’re getting your full employer match if any is available!
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